Chapter 24 Sole Proprietorships, Partnerships, and Limited Liability Companies

1. Chapter 24Sole Proprietorships, Partnerships, and Limited Liability Companies

2. Learning Objectives • Which form of business organization is the simplest? Which form arises from an agreement between two or more persons to carry on a business for profit? • What are the three essential elements of a partnership? • What is meant by joint and several liability? Why is this often considered to be a disadvantage of the partnership form of business? • Why do professional groups organize as a limited liability partnership? How does this form differ from a general partnership? • What is a limited liability company? What are some of the advantages and disadvantages of this business form?

3. Introduction • Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: • Ease of creation. • Owners’ liability. • Tax considerations. • Need for Capital.

4. Sole Proprietorships The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship.

5. The Law Governing Partnerships • Partners are agents and fiduciaries of one another, but differ from agents in that they are also co-owners and have equal rights to manage and share in the profits and losses. • If a commercial enterprise shares profits and losses, a partnership will be inferred. • Uniform Partnership Act.

6. The Law Governing Partnerships • In the absence of a partnership agreement (oral or written) state statutes govern the rights among partners: • Management: equal, each one vote, majority wins; need unanimous consent for some actions. • Partnership Interest: equal profits, losses shared as profits shared. • Uniform Partnership Act.

7. Definition of Partnership (General) Partnership is an “association of two or more persons to carry on business for profit as co-owners a business for profit.” (UPA)

8. Partnership Status • Sharing profits or losses. • Joint ownership of the business. • Equal right in the management of the business. • No inference if: • Debt. • Wages. • Rent. • Annuity. • Sale of goodwill. • CASE 24.1Cap Care Group, Inc. v. McDonald (2002).

9. Partnership Status • Today, many states recognize the partnership as a separate legal entity for the following purposes: • To sue and be sued (for federal questions, yes; for state questions, differs). • To have judgments collected against it’s assets, and individual partners’ assets.

10. Joint Property Ownership and Property Status • Partnerships are recognized as separate legal entities (cont’d): • To own partnership property. • To convey partnership property. • At common law -- property owned in tenancy in partnership, all partners had to be named and sign the conveyance. • Under UPA partnership property can be held and sold in firm name. • Entity vs. Aggregate.

11. Partnership Formation • Generally, agreements to form a partnership can be: • Oral. • Written, or • Implied by Conduct.

12. Partnership Formation • Partnership agreements (Articles of Partnership) can be oral unless Statute of Frauds requires a written agreement. Practically, agreements should be in writing. • Partners must have legal capacity. UPA permits corporations to be a partner. • A Corporation as a Partner. • Partnership By Estoppel: parties who are not partners hold themselves out to 3rd Parties and 3rd Party relies to her detriment.

13. Rights of Partners • Management: equal, each one vote, majority wins; need unanimous consent for some actions. • Partnership Interest: equal profits, losses shared as profits shared. • Compensation: generally, none.

14. Rights of Partners • Inspection of the Books: always and also by rep. of deceased partner. • Accounting: when other partner(s) committing fraud, embezzlement, wrongful exclusion, or anytime it is just and reasonable. • Property Rights 

15. Rights of Partners • Each partner has a property right, which includes: • An interest in the partnership. • A right in specific partnership property. • A right to participate in the management of the partnership, as mentioned above.

16. Duties and Liabilities of Partners • Fiduciary Duties: Partners are fiduciaries and general agents of one another and the partnership. • Authority of Partners: Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity. • Scope of Implied Powers. • CASE 24.2Helpinstill v. Regions Bank (2000).

17. Duties and Liabilities of Partners • Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her. • Joint and Several Liability for Torts: 3rd party can sue either one or all partners. 3rd party may collect against personal assets of all partners. • Liability of Incoming Partner & Outgoing Partner. Newly admitted partner has no personal liability for existing partnership debts and obligations.

18. Partner’s Dissociation • Occurs when a partner ceases to be associated with the carrying on of partnership business. • Events causing dissociation: • Giving notice of withdrawal. • Contractual event. • Expelled. • Bankruptcy, assignment to creditors, incapacity or death. • Wrongful Dissociation. • Effects of Dissociation.

19. Partnership Termination • Dissolution (termination) can occur for a variety of reasons: • Partners agree to terminate. • Partner’s withdrawal can terminate. • Termination has two stages: • Dissolution and “Winding Up” (actual process of collecting and distributing the partnership assets).

20. Dissolution • By Acts of the Partners: • Partners can agree to Agreement. • Partner’s Withdrawal. • Partnership for term – breach. • No term -- no breach. • Admission of a new partner. • Not a transfer of a partner’s interest. • By assignment or attachment by creditor.

21. Dissolution By Operation of Law: • Death of a partner. • Bankruptcy of a partner. • Bankruptcy of partnership. • Illegality.

22. Winding Up • Partners have no authority after dissolution occurs except to: • Complete transactions already begun. • Wind up by collecting and preserving partnership assets, discharging liabilities, and accounting to each partner for the value of his share.

23. Winding Up • If partner has violated the partnership agreement, he: • Must pay damages. • May not participate in winding up. • But other partners may choose to continue. • If partner dies: • Other partners act as fiduciaries. • Accounting to deceased partner’s estate. • Survivors get paid for their services.

24. Winding Up • Partnership obligations are paid in the following order: • First, 3rd party creditors. • Second, partner loans to partnership. • Third, return of capital contributions. • Fourth, distribution of the balance, if any to partners.

25. Limited Liability Partnerships • Creature of state statute, similar to an LLC, except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants). • LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

26. Liability in an LLP • Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets. • The LLP allows professionals to avoid personal liability for the malpractice of other partners. • Supervising Partner is also liable for acts of subordinate.

27. Family Limited Liability Partnerships • FLLP is a limited liability partnership in which the majority of the partners are related to each other. • Used frequently for agriculture.

28. Limited Partnerships • Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner. • Limits the liability of some of its owners (the limited partners) to their investment. • A LP is a creature of state statute. Filing a certificate with the Secretary of State is required.

29. LP -- Rights and Liabilities • The General partner assumes all management and personal liability. • General partners are personally liable to 3rd parties for breach of contract and tort liability. • However, a corporation (or an LLC) can be a general partner and have limited liability.

30. LP – Rights and Liabilities • Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. • A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. • CASE 24.3Smith v. Fairfax Realty, Inc. (2003). • Limited partners have the right to inspect the LP’s books.

31. LP – Dissolution • On dissolution, the limited partner is entitled to return of capital contributions. • LP interests are considered securities and regulated by both federal and state securities laws. • Limited partners’ liability is limited to the capital investment.

32. LP – Dissolution • Dissolved in much the same way as a general partnership (Chapter 33). • Retirement, withdrawal, death bankruptcy or mental incompetence of a general partner will trigger dissolution unless the remaining GP’s consent to continue. • Creditors are paid first then partners.

33. Limited Liability Limited Partnerships • Limited Liability Limited Partnership is a type of limited partnership. • Difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment. • Most states do not allow for LLLP’s.

34. Nature of the Limited Liability Company • Like corporations, LLC’s are creatures of state law. • The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). • Members of an LLC enjoy limited liability. • Can a third party pierce the LLC “veil” and hold managing member liable?

35. LLC Formation • Articles of Organization require: • Name of Business. • Principal Address. • Name and Address of Registered Agent. • Names of the Owners; and • How the LLC will be managed. • Business name must include LLC or Limited Liability Company.

36. Jurisdictional Requirements • An LLC is a legal entity separate from its owners. • For federal jurisdiction based on diversity, an LLC may be treated differently than a corporation. • For diversity purposes the citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions.

37. Advantages andDisadvantages of the LLC

38. The LLC Operating Agreement • Operating agreement is analogous to corporation’s bylaws. • Operating agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues. • Generally, if the operating agreement is silent, courts will apply partnership principles.

39. Management of an LLC • There are two options for management, generally set forth in the articles of organization: • Member-Managed: all of the members participate in management, like a partnership. • Manager-Managed: members are elected to manage the LLC. • If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.

40. Operating Procedures • Members can set forth LLC decision-making procedures in operating agreement. • Operating agreement can include: • Meeting protocols. • Voting rights.

41. Special Business Forms • Joint Venture: two or more entities combine efforts or property for a single transaction or project. • Unless agreed otherwise, JV’s share profits and losses equally. • Common in international transactions when U.S. companies wish to expand overseas.

42. JV Characteristics • Resembles a partnership and is taxed like a partnership. However, a JV is limited in time and scope, whereas a partnership is an ongoing business. Other differences: • JV members has less implied and apparent authority than partners. • Death of JV member does not terminate JV. • JV members can specify duration. If not, then JV terminates when purpose is accomplished.